Achieving financial security gives you peace of mind, reduces stress, and lets you focus on your goals. Mutual funds can help you build a stronger financial base for your future. Taking a loan against mutual funds can be a useful tool for reaching financial security. But how does a loan against mutual funds work? Let’s take a look.
How does a loan against mutual funds work?
A loan against mutual funds allows you to borrow money using your mutual fund investments as collateral. This way, you get cash without selling your investments, avoiding tax issues and keeping your investment positions intact.
When you use your mutual funds as collateral for a loan, the amount you can borrow depends on two things. First, the specific mutual fund schemes you have invested in and second, the lending policies of the financial institution. These mutual fund units act as security for the loan.
The bank holds these mutual fund units as security until you fully repay the loan. Despite being used as collateral, your mutual fund investments remain active, so they can still earn returns. Once you repay the loan, the bank releases its claim on the mutual fund units, and you regain full control over your investments.
If you fail to repay the loan, the bank tells the mutual fund company to sell your units. The money from selling these units is used to pay off the loan.
Mechanics of loan against mutual funds
Eligibility criteria
A loan against mutual funds is available to Indian nationals aged 18 to 75. To be eligible, you need a credit score of 500 or higher or no prior credit history.
Additionally, you must have a valid Permanent Account Number (PAN) card. With one PAN card, you can open up to two loan accounts: one for equity mutual funds and one for debt mutual funds. Both types of mutual fund investments can be used as collateral for loans.
Loan amount
The loan amount depends on the value of your mutual fund units used as collateral. Lenders check the current value of your mutual fund units and offer a loan that is a percentage of this value, called the Net Asset Value (NAV).
For example, if your mutual fund units are worth ₹10 lakhs, the lender might offer you a loan for 50% to 80% of that amount, resulting in a loan between ₹5 lakhs and ₹8 lakhs. The exact amount depends on both your mutual funds’ value and the lender’s rules.
Interest rates
Interest rates for loans against mutual funds vary based on several factors. Different banks and financial institutions offer different rates. Moreover, the loan amount and overall market conditions also play significant roles.
For instance, if market interest rates are low, the rates for loans against mutual funds might also be low. The interest rate you receive depends on the lender, the loan amount, and the current market situation.
Loan tenure
The tenure of a loan against mutual funds is generally shorter compared to other types of loans, designed for short-term financial needs. So, loan periods range from a few months to a few years.
For example, a home loan might last for 15 to 30 years, but a loan against mutual funds might only last for 1 to 3 years. The shorter tenure aligns with the loan’s purpose and the nature of the collateral involved.
Repayment
Repayment terms for loans against mutual funds differ depending on the lender. Usually, you have to make regular payments that cover both the principal and the interest.
For example, you might pay a part of the loan amount along with the interest each month. Some lenders may offer different schedules, like quarterly or bi-annual payments. Therefore, check your lender’s specific terms to understand the exact repayment requirements.
Advantages of loan against mutual funds
Liquidity
Liquidity means how easily you can get cash. When you take a loan against your mutual funds, you get money fast without selling your units. This keeps your investments safe and lets you keep earning future returns. So, you can quickly get the cash you need while still benefiting from your investments.
Tax efficiency
Tax efficiency is a big advantage of using a loan against mutual funds. When you keep ownership of your mutual fund units, you can avoid the capital gains tax that happens when you sell investments for profit. So, this method helps you manage money better and lowers your tax load, giving you a tax-friendly way to get cash.
Convenience
Convenience is a major advantage of utilizing a loan against mutual funds. Because you can use your investments as collateral without liquidating them.
This is attractive to people who want to keep their investments and stick to long-term financial plans. These loans are easy and fast and you can get money without much trouble.
When to consider a loan against mutual funds?
Short-term financial needs
A loan against mutual funds is perfect for meeting short-term financial needs. It gives you quick access to funds for urgent expenses like medical bills or repairs.
So, with these loans, you can handle short-term needs without sacrificing long-term goals. They offer a practical solution for getting quick cash while safeguarding investments.
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Avoiding capital gains tax
Investors might choose a loan against mutual funds to avoid paying capital gains tax. These loans enable you to access funds without triggering the tax. So, it is a tax-efficient way to access funds without facing tax liabilities.
Final words
A loan against mutual funds offers a straightforward and tax-efficient method of obtaining funds without selling your investments. However, check the benefits and risks carefully to determine whether this option aligns with your financial situation and goals.
